Outlook 2016: US Equities
- Strong employment market and robust consumer confidence make for a positive outlook
- Active fund management to differentiate itself against backdrop of increased volatility
- We are focused on sectors with secular expansion potential and prefer a domestic tilt where necessary
There is little doubt that some of the biggest risks to equity markets last year, depressed commodity prices, slowing growth in China, uncertain economic data points in Europe as well as the US, all accompanied by dollar strength – will affect 2016 as well.
We continue, however, to be constructive about the outlook for US equities, encouraged predominantly by ongoing strength in the employment market, increased evidence of rising wages, better household balance sheets, and robust consumer confidence.
Strong consumer to drive US growth
We are optimistic about the prospects for US growth based on the strength of the consumer, which ultimately accounts for two thirds of the economy.
Based on current activity indicators, we believe the US economy is growing 2-3% annually, roughly in-line with trend-line GDP growth which, when combined with moderate increases in corporate profitability, 1-2% stock repurchases, and modest multiple expansion, can provide attractive equity returns.
Other potential positives include:
- An accommodative European Central Bank and Bank of Japan
- China’s ability to engineer modest growth
- The potential for dollar stabilisation and/or reversion in commodity prices/emerging markets driving greater overall global growth.
- Further earnings revisions associated with those companies more exposed to oil and other commodity prices, emerging markets, and/or further dollar strength.
Certainly, slowing growth in China, subdued commodity prices, and uncertain economic data points in Europe and the US could lead to increased levels of volatility.
But given greater levels of dispersion associated with this volatility, this should provide an environment in which active management could differentiate itself from an asset management industry, struggling to beat its benchmark over the last five years.
Industry disruption creates secular growth opportunities
We see continued investment opportunity in the technology sector, our biggest overweight, as cloud computing usurps traditional business models in areas like enterprise resource planning and human resources.
The cloud offers lower total cost of ownership, faster time to market, and more flexible and user-friendly interfaces.
Also, as consumers spend more time online and on mobile devices, historical means of monetisation and commerce will give way to newer, disruptive approaches.
A stronger consumer, shopping online
We’re also constructive on the US consumer, emboldened by upward pressure on wages associated with improving employment and lower gas prices.
We believe in e-commerce over traditional ‘big box’ retailing as selection, price, and convenience drive market-share gains.
Today e-commerce only accounts for 7% of overall retail sales, but it is growing at a compound annual growth rate of 19% versus 4% for traditional retail.
Where traditional bricks and mortar will continue to prevail is through brand and merchandising and categories that don’t lend themselves to online, and in service.
Many of these names will also benefit from the resurgent consumer, when steady jobs growth over the last two years begins to manifest itself in improved wages and greater consumer expenditures.
US pharmaceuticals offer hidden value but regulatory uncertainty tempers enthusiasm
In US pharmaceuticals and biotechnology there are myriad, late-stage drug pipelines that are undervalued by Wall Street, in lieu of overvalued single-drug franchises that haven’t shown research and development efficacy and are a focus for competition/generic substitutes.
But our enthusiasm is tempered heading into an election year as the time of unchallenged pricing in pharmaceuticals is coming to an end.
Direct government intervention is unlikely, but multiples will be constrained.
Industrials face multiple challenges
As we look at depressed commodities, particularly oil and gas, and at China battling to shore up weaker growth, it’s difficult to be constructive on industrials, so we are underweight this sector.
Instead, we focus on the secular growth evident in certain pockets such as environmental/analytics, auto manufacturing, residential construction/HVAC (heating, ventilation and air conditioning).
We’re also watching short-cycle and inventories intently as signs of dollar stabilisation, commodity, or emerging market economic growth would really drive positive earnings revisions in the group.
Strong US dollar points to domestic exposure
As interest rate differentials persist, the result of US Federal Reserve monetary policy tightening versus European and Japanese QE, dollar strength should remain a theme in 2016.
Accordingly, we must be mindful of multi-national sales sensitivity in those areas of the S&P 500 (34% exposure to international overall) which have the highest overseas sales.
We are optimistic about the prospects for US growth based on the strength of the consumer.
These include the technology (roughly 50% exposed to international sales), materials (45%), and industrials (40%) sectors.
In technology, we feel confident that our stronger secular growth will overwhelm headwinds from dollar strength, while in industrials and materials the impact to multi-nationals was quite evident in 2015.
As such, at the margin, we’ve tried to emphasise domestic versus international exposure.
Growth should outperform value
Historically, in an environment with modest economic growth, growth stocks tend to outperform value.
We are confident in the prospects for the consumer given strong monthly jobs data, good housing starts and robust consumer confidence.
However wages and inflation are still fairly muted and the industrial economy is challenged.
Against that backdrop and the resulting 2% or so GDP growth we’d extrapolate, investors should gravitate to those stocks where growth is more evident.
This informs our penchant for secular growth (via overweights in technology and consumer discretionary and decent exposure in staples) and is notable in our growth premium to our S&P 500 benchmark.
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